A snail's pace

Challenges and breakthroughs in transforming the South African financial sector

Transformation in the asset management industry is moving at a snail’s pace, as was reported in the recently published 2017 BEE.conomics survey. An entrenched oligopoly and ineffective policies have left the financial services industry woefully untransformed.

Since 2009, the volume of assets under management (AuM) by black asset managers has grown by 355% from R91.4 billion to R415.5 billion this year, with the number of black-owned asset management companies more than tripling from only 14 to 45 in that time.

However, this was still dwarfed by the overall R4.6 trillion of assets currently being managed by private sector asset managers in South Africa.

According to the latest BEE.conomics survey, less than 10% of AuM are managed by majority black owned fund managers. The value of assets the black investment management industry collectively manage is less than just one of the top ten biggest asset managers in South Africa.

As of 31 December 2016, the total size of the Collective Investment Schemes (unit trusts) industry was R2 trillion, but the value managed by black-owned asset management firms was a mere R87.3 billion, or 4.35% of the total.

Only 13 firms have passed the critical R5 billion AuM mark, where they are able to benefit from significant economies of scale and attract bigger pieces of business. Twelve black firms have less than R100 million in AuM.

While it’s possible for firms to survive without reaching the R5 billion mark, as four of the black-owned asset managers who are older than 10 years and have yet to pass this level prove, they can never hope to compete with the top firms.

This is not just limited to the asset management sector. The overall financial services sector is severely untransformed from both a structural and demographic perspective. The “Big Four” banks control over 90% of the industry and none of these four have been able to reach the targets set out in the 2012 Financial Sector Code.

Contribution over compliance

Nothing is achieved overnight and transformation should not be done for its own sake or for the sake of compliance. Structural imbalance limits economic opportunity for the majority of South Africans. South Africa started 2017 in a technical recession and in the second quarter reached its highest level of unemployment, at 27.7%, which is 1.1 percentage points higher than the same period last year. Statistics South Africa reports that the country’s real unemployment rate (according to its expanded definition) was actually 36.6%. The unemployment rate for black Africans has remained unchanged since last year at 40.9% while it has actually dropped for whites from 8.6% last year to 7.9% now. The unemployment rate for coloureds and Indians went up from 28% to 30% and from 16.6% to 19.8% respectively.

Unless the economy is transformed at a fundamental level, any social or enterprise development programmes that are implemented will amount to nothing more than veneer, seeming to benefit a selected few from the historically disadvantaged rather than the majority. However, it does not follow that transformation efforts should seek to improve the lot of any one of the population groups while taking away from the other. Transformation efforts should seek to create value for all South Africans. Black Africans make up 66.4% of the labour force, so it will naturally be a bigger challenge to tackle unemployment and associated issues in this segment.

The key is to recognise that the financial sector will be the driving force in meeting this challenge, as it provides the crucial infrastructure for the financing of large and small enterprises in the public and private sector. It is therefore vital that the industry is transformed from the inside-out, in its leadership and ownership structures. As one of the most highly regulated sectors, policies need to be adjusted in a way that they fast-track transformation.

Up until now, B-BBEE compliance has been voluntary, but this has only proved to be partially effective and the market dominance of the major firms has gone unchallenged by new entrants. The Government (in consultation with all relevant stakeholders) needs to enact strong legislation that gradually transfers the control of the financial services industry into the hands of a leadership structure that not only reflects the unique demographic of the country, but delivers real benefits all its citizens, and not just a select few. These benefits would be in the form of key positions, access to capital for small business, skills development, and broad-based shareholding and policy formulation.

Risk factors

The risks of a failure to transform are vast and far-reaching, including a continued rise in unemployment and poverty, along with the spread of extremist political doctrine, which becomes more attractive as the citizenry feels increasingly dispossessed. The service delivery protests that have become a regular feature of South Africa’s labour climate will only grow in intensity and frequency. Crime levels will increase as the hungry grow more desperate. Access to marketable local skills will drop, forcing firms to import key expertise, further alienating themselves from the public. While the current political climate is surely discouraging to investors, it is only a part of the story. Should a more palatable regime enter power, business confidence will improve to the extent that investors release excess capital for expansion and infrastructure development. New jobs will be created but the structural fundamentals that drive rising inequality will not be addressed quickly enough.

Black industrialisation

In May, parliamentary hearings into the transformation of the financial services sector were held to investigate the challenges facing the industry and its failure to transform. During the debates, several propositions were made. One suggestion by the Department of Trade and Industry was that a compulsory minimum broad-based black economic empowerment (B-BBEE) level be a condition for listing on the JSE and other exchanges. Another was that instead of just requiring voluntary compliance through the Codes, penalties should be imposed on companies that do not comply with management and employment equity targets. However, this would not be enough to deliver scale. To truly transform the sector and create companies that can compete with the largest firms, there needs to be consolidation among smaller black-owned asset managers. Only through a consolidated effort will the economy produce progressive institutions that can achieve significant economies of scale and compete with the larger players, locally and globally. These economies of scale will not only enable companies to create scale but allow them to achieve vertical integration – expansion along the value chain to create new banks, insurance companies and administrators.

Black industrialists must have better access to affordable funding and regulations need to be radically engineered to support new entrants.

Procurement regulations

The Association for Black Securities and Investment Professionals has been working hard through its participation in the financial sector charter council, which played a major role in the redrafting of 2012 financial sector codes in 2016, to enact some of these changes. For instance, a B-BBEE scorecard for retirement funds will be included in the next revision of the Financial Sector Code to monitor the procurement of service providers.

This is vital as it will affect how trustees of retirement funds appoint asset managers. Currently, trustees use the services of asset consultants, who offer recommendations on which asset managers to appoint. Usually, these asset consultants choose from the same concentrated pool of asset managers, largely ignoring the newer smaller firms.

Twin peaks

President Zuma’s recent signing into law of the “Twin Peaks” model of financial sector regulation will provide some robust monitoring of any rules that are developed. Under this new environment, a Financial Sector Conduct Authority (FSCA) will be responsible for the conduct of all financial sector participants and the Prudential Authority under the Reserve Bank will be responsible for financial stability monitoring. This is a shift from the past where the banking sector was regulated by the South African Reserve Bank (SARB), while the savings and investment industry was regulated by the Financial Services Board (FSB). While this is a positive change, it only deals with structural changes in the way the financial sector is regulated and supervised, and not much in terms of meaningful transformation.

Financial Sector Summit

Following the May 2017 Parliamentary hearings, the industry committed to holding a Financial Sector Summit in 2018 to expand the debate on what a more robust legislative regime for transformation will look like.

The challenge is that this regime will need to be developed in a way that delivers sustainable change without alienating potential investors, local and international. A tough job indeed, but a major overhaul is needed. The current situation is untenable, as incumbents have no real incentive to transform and will just continue in their old ways, unless they are gently compelled by law to move in the right direction.